TAXLITIGATOR – Tax Controversy (Civil & Criminal) Report

In a recent Division Opinion[i], the Tax Court granted petitioners a hardship waiver for an untimely IRA rollover, allowing them to exclude the amount from income and avoid an early distribution penalty.  In a broad sense, the case illustrates the pitfalls of retirement account distributions.  A closer examination of the facts, however, suggests a case where the administrative process failed, and the Tax Court was needed to get the right result.  From a distance, but as a former Counsel attorney, I find it hard to fathom why this case went all the way to trial.  Congratulations to the Fordham Clinic that handled the case.

John Trimmer retired from the NYPD after 20 years. Before retiring he had lined up a job as a security officer for the New York Stock Exchange to supplement his pension income.  After retiring, the NYSE job fell through.  Mr. Trimmer couldn’t find another job and the NYPD does not rehire retired officers.  Mr. Trimmer began suffering from major depression.  His behavior changed in all aspects of his life.

After his depression started, Mr. Trimmer received two checks totaling approximately $100,000 from his retirement accounts. The checks sat on his dresser for over a month before they were deposited into his checking account.  Mrs. Trimmer was not involved in this matter and believed her husband was handling his retirement assets.  Mr. Trimmer received a Form 1099-R indicating the distributions were taxable.  Mr. Trimmer’s accountant advised him to put the funds into an IRA, which he did shortly after.  The distribution was reported as not taxable.

The IRS issued a Notice CP2000, an automated notice, indicating the Trimmers failed to report the distribution and were liable for a 10% penalty. Mr. Trimmer responded with an eloquent letter explaining his situation, the depression he suffered, and that the tax liability would cripple his family.  The IRS sent a response indicating the taxpayers didn’t need to do anything further.  Three days later, the IRS issued a letter rejecting the requested relief.  A Notice of Deficiency was subsequently issued.

At trial the Taxpayers agreed the distribution would ordinarily be taxable, but that they qualified for a hardship waiver because of Mr. Trimmer’s depression. The IRS not only disagreed that Mr. Trimmer qualified for the hardship waiver, but argued that the examination division lacked authority to consider a hardship waiver, and that any consideration of a hardship waiver is not subject to judicial review.  The IRS further argued that the Taxpayers’ expert should be excluded.

The IRS argued that the Taxpayers failed to follow the rules in Rev. Proc. 2003-16, which provided guidance regarding hardship waivers. Specifically, it mentioned that a taxpayer needed to submit a Private Letter Ruling request and include the fee as set out in the Rev. Proc.  In 2016, the IRS revised the Rev. Proc. and made clear that exam could consider the hardship waiver.  The Court held that the exam division always had the authority to consider a hardship waiver.[ii]

The Court additionally held that it had jurisdiction to review the IRS’ determination and used an abuse of discretion standard.  The IRS argument that the Court lacked jurisdiction to review the hardship denial is yet another attempt by the IRS to limit taxpayer’s rights.  The hardship determination is fundamental to the ultimate deficiency determination.  If the hardship is granted, the distribution is not taxable.  The decision has a detailed analysis of this issue, noting that there is a strong presumption that acts of administrative discretion are subject to review.[iii]  Nothing in the statute indicated the hardship decision was not subject to review.[iv]

The IRS next tried to exclude the taxpayer’s expert witness, who was an unpaid clinical professor at Fordham with degrees in social work.[v]  Again the opinion is detailed in this section and a good primer on expert witnesses.  The Court ultimately denied all of the IRS objections.  Any flaws that the Taxpayers’ expert had seemed to stem largely from the fact that because of limited resources the Taxpayers couldn’t hire an outside expert.  The expert also came from a Fordham clinic.

After 44 pages, the Court addresses the merits of the Taxpayer’s hardship claim and grants the waiver, finding that the failure to waive the 60-day rollover requirement was against “equity or good conscience”. The Court found that the Taxpayer’s in no way profited from retaining the funds and the Mr. Trimmer suffered from a disability.

From the outside, it is hard to understand why this case didn’t settle. The deficiency was not large, the Taxpayers’ put the money in an IRA without benefitting, albeit untimely, and most of all, Mr. Trimmer suffered from depression.  The IRS tried to dispute that in part by arguing Mr. Trimmer refereed a soccer game on occasion.  This case seems to show a severe lack of empathy or perhaps a lack of understanding of mental illnesses such as depression.  Other recent cases have shown the IRS to seek restrictive interpretations of hardship as well as trying to avoid producing documents that would reduce the taxpayers liability.  The budget crunch and heavy caseload that IRS employees currently have and will likely have for the foreseeable future, don’t leave me optimistic that we can expect taxpayer friendly changes going forward.

JONATHAN KALINSKI specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.

Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.

[i] Trimmer v. Commissioner, 148 T.C. No. 14 (2017)

[ii] Id. at 15.

[iii] Id. at 21.

[iv] Id. at 22.

[v] Id. at 27.